Virtual assets the target of updated AML/CFT recommendations

The Financial Action Task Force (FATF) concluded, on 22 February 2019, a week of discussions in Paris with 800 officials representing 205 jurisdictions, the IMF, UN, World Bank and others in attendance.

Amongst these discussions, there was talk on how the AML/CFT regime applies to virtual assets and virtual asset service providers (VASPs).

In October 2018, FATF committed to addressing the risks of virtual assets and updated the FATF Recommendations for how countries must regulate for virtual assets. It amended Recommendation 15 on New Technologies, stating that “to manage and mitigate the risks emerging from virtual assets, countries should ensure that VASPs are regulated for AML/CFT purposes, and licensed or registered and subject to effective systems for monitoring and ensuring compliance with the relevant measures called for in the FATF Recommendations”.

The FATF Plenary has finalised a new Interpretive Note on Recommendation 15 to clarify how countries must regulate virtual assets to meet their international obligations. This will be formally adopted in June 2019.

A link to the FATF’s public statement and text of the Interpretive Note is available here.

Who needs to read it? Why?

Those involved in the business of virtual assets should closely watch these developments. The ambiguity around the application of the AML/CFT regime to their activities is fading and these businesses should expect to see increased scrutiny over their AML/CFT compliance in the near future.

What does it cover?

Recommendation 15 along with the new Interpretive Note set out how virtual assets and VASPs should be regulated.

What are virtual assets and VASPs?

A virtual asset is a “digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes.” Virtual assets not only encompass cryptocurrencies but also many types of digital tokens. However, virtual assets do not include digital representations of fiat currencies, securities and other financial assets that are already covered elsewhere in the FATF Recommendations.

The nature of a virtual asset is extremely broad and will capture any “property,” “proceeds,” “funds”, “funds or other assets,” or other “corresponding value”.

VASP means any natural or legal person who is not covered elsewhere under the Recommendations, and as a business conducts one or more of the following activities or operations for or on behalf of another natural or legal person:

exchange between virtual assets and fiat currencies;

exchange between one or more forms of virtual assets;

transfer of virtual assets;

safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets; and

participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.

How should virtual assets and VASPs be regulated?

Countries are expected to implement regulations to address the money laundering and terrorist financing risks emerging from virtual asset activities and the activities or operations of VASPs.

VASPs should be required to be licensed or registered. At a minimum, VASPs should be required to be licensed or registered in the jurisdiction(s) where they are created. This references to creating a legal person, include incorporation of companies or any other mechanism that is used.

In cases where the VASP is a natural person, they should be required to be licensed or registered in the jurisdiction where their place of business is located. “Place of business” is not defined.

Countries may also require VASPs that offer products and/or services to customers in their jurisdiction or which conduct operations from it to be licensed.

VASPs should be required to conduct customer due diligence on any “occasional transaction” above USD/EUR 1,000.

VASPs should be required to obtain and hold accurate originator information and beneficiary information on virtual asset transfers. Note that this recommendation has not yet been finalised and is subject to private sector input.

Local regulation

The FATF Recommendations do not have direct legal effect in any jurisdictions that require separate activity by the relevant legislature. Instead, countries are required to pass local laws to give effect to the FATF Recommendations. Currently, one of the issues FATF is attempting to address is the difference between how countries are applying AML/CFT to virtual assets.

Our view

The FATF Recommendation calls for broad regulation of virtual assets and VASPs that, at minimum, have a place of business within a country, but provides discretion to legislators to go further to regulate for a wider scope of circumstances.

The Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT Act) in New Zealand is nearing the tenth anniversary of its enactment and sixth anniversary of coming into force. When the AML/CFT Act was enacted, the idea of virtual assets was almost unknown—the first catalyst for blockchain, Satoshi Nakamoto’s white paper for Bitcoin, was not published until October 2008 and was not considered in the legislative process leading to the AML/CFT Act. New Zealand has still not yet responded to these technological changes with any steps to amend the relevant NZ legislation. The result is that virtual asset activities operate in a limbo and are neither clearly caught, nor excluded, under the current AML/CFT Act.

New Zealand’s lack of response is in contrast to comparable jurisdictions such as Australia and the United Kingdom which have actively reformed their AML/CFT regimes in line with international standards.

In New Zealand, whether the scope of the AML/CFT regime presently captures virtual asset activities depends on whether the business falls within one of the “financial activities” listed in the definition of “financial institution” in the AML/CFT Act. These limbs reflect traditional types of financial activities and the extent that virtual asset activities may be forced into the meaning is debatable. The original drafting from 2009 largely exists today with changes made in 2013 to align with the Financial Markets Conduct Act 2013 and in 2018 for the implementation of Phase II, neither addressing the issue of virtual assets.

New Zealand’s lack of clarity on the issues comes at a cost to business and growth of the FinTech sector. A lack of clarity and certainty of the rules is unsustainable and makes it difficult for both businesses and supervisors to confidently operate. Providing a clear and consistent regulatory framework that expressly covers virtual assets would not only bring New Zealand in line with international standards, but support and promote New Zealand as a place of business for the growing tech sector.

In light of FATF’s updated recommendations, now is the time for New Zealand to take the opportunity to develop its regulation and position itself as a market leader, providing first class rules that promote the innovation and growth of the financial technology industry as a legitimate and safe form of business, but also tackle the money laundering and terrorism financing risks involved. The two objectives are not mutually exclusive; quality legislation and regulation which build confidence in the virtual asset sector will attract competitive and responsible businesses that wish to associate with a reputable regime.

A specific issue which will require consideration is what “place of business” specifically means. While the Interpretive Note seems to intend that a VASP should be licensed or registered in the “jurisdiction(s)” that it would be required to be incorporated, it is unclear whether a natural person should only be required to be registered in a single jurisdiction that represents the principal place of business. In New Zealand, under the Financial Service Providers (Registration and Dispute Resolution) Act 2008, there has been a fraught issue as to assessing the threshold of conduct needed to meet the “place of business” test, with some businesses being deregistered where their operations in New Zealand are considered to be limited. Alignment with the new FATF Standards might see the issue approached in a new light.

What next?

The interpretive note is to be formally adopted by FATF in June 2019.

Ahead of its adoption, FATF has called for private sector entities to provide written comments on paragraph 7(b) of the Interpretive Note on obtaining and holding originator information. The deadline for comments is 26 April 2019. FATF will then consult in May to consider how the Recommendations should reflect technical implementations ahead of that final adoption in June.

New Zealand will need to consider whether and how its legislation (the AML/CFT Act) needs to be amended to respond to the updated recommendations. New Zealand will be expected to comply with its international obligations, and it will be motivated to do so quickly with New Zealand being subject to its mutual evaluation by FATF in 2020.

If you have any questions on how the AML/CFT regime applies to your business, or would like assistance in making a comment to FATF, please contact one of our experts.